Friday, September 7, 2007


A paper by Professor Richard Tol, Vrije Universiteit and Carnegie Mellon.

211 estimates of the social cost of carbon are included in a meta-analysis. The results confirm that a lower discount rate implies a higher estimate; and that higher estimates are found in the gray literature. It is also found that there is a downward trend in the economic impact estimates of the climate; that the Stern Review’s estimates of the social cost of carbon is an outlier; and that the right tail of the distribution is fat. There is a fair chance that the annual climate liability exceeds the annual income of many people.

1. Introduction
Estimates of the social cost of carbon (dioxide emissions), or the marginal damage cost of climate change are an essential ingredient to any assessment of climate policy. The social cost of carbon (SCC) is a first estimate of the Pigou tax that should be placed on carbon dioxide emissions.

Indeed, if the SCC is computed along a trajectory in which the marginal costs of emission reduction equal the SCC, the SCC is the Pigou tax. Few would argue that climate policy should be set by cost-benefit analysis alone, but most economists would feel queasy if climate policy would drift too far from its optimum. This paper presents a meta-analysis of over 200 estimates of the SCC.

...The Stern Review also published an estimate of the SCC. Although many newspapers publicised the Stern Review as entirely novel, its estimate is in fact number 211 in chronological order. A number of people argued that the Stern Review is an outlier. This paper formally tests this assertion.

Thirdly, the Fourth Assessment Report (AR4) of the Intergovernmental Panel on Climate Change (IPCC) was published (Schneider et al., 2007). It argues that economic estimates of the impact of climate change have become more pessimistic since the previous report of 2001. This paper formally tests this assertion as well.

Fourthly, Weitzman (2007) argues that climate economics has unduly focussed on the middle of the probability distribution, and should have focussed on the tails. This paper supports that argument.

Fourthly, I estimate the risk premium and the fraction of people that would be able to afford the estimated carbon tax....

...There are three implications. Firstly, greenhouse gas emission reduction today is justified.The median of the Fisher-Tippett kernel density for peer-reviewed estimates with a 3% pure rate of time preference and without equity weights, is $20/tC. This compares to a future price of carbon permits of $8/tC in the European Union (and a spot price of ¢3/tC).

The case for intensification of climate policy can be made with conservative assumptions. One does not have to rely on dodgy analysis as in Schneider et al. (2007) and Stern et al. (2006). Secondly, the uncertainty is so large that a considerable risk premium is warranted.

With the conservative assumptions above, the mean equals $23/tC and the certainty-equivalent $25/tC. More importantly, there is a 1% probability that the social cost of carbon is greater than $78/tC.

This number rapidly increases if we use a lower discount rate – as may well be appropriate for a problem with such a long time horizon – and if we allow for the possibility that there is some truth in the scare-mongering of the gray literature.
27 page PDF
HT: Environmental Evaluation & Cost-Benefit Analysis